Mergers and acquisitions take place when an acquiring firm, called the bidder, looks to take control over a target company, called the seller. The bidder can pay the seller in cash (the “cheapest” option), by issuing debt, or by paying in equity (the most “expensive” option). Financing methods all depend on the nature of the deal. With high levels of volatility, it is extremely hard to finance deals with debt or equity. Furthermore, investors are reaching for cash to beef up their balance sheets (that will slow deal activity).
M&A is defined by one simple term - strategy. Strategic growth and divestiture (selling a subsidiary) are the two most common transactions. Growth strategies are more popular because they offer “additive” value. Growth can be either “organic” or “external”. Again, the M&A game of strategy is based upon cost-benefit analysis, aka “make or buy decisions”. There are so many factors that go into deals that make every approach different. What matters is the end goal of creating value for the firm, maximizing future cashflows, and generating wealth for shareholders. In a post COVID world, the concept of “strategy” is going to take on a completely new definition. There will be greater demand for “organic growth strategies” in order to hedge against possible future “tail-risk” or better overall positioning.
Two derivatives of M&A activity are “the power of synergism” and “the control premium”. The most simple way to describe synergy is 1 + 1 = 3. The output is greater than the combined inputs because of post deal activity. For example, a bidder (ABC) acquires a target seller (XYZ) where the seller is a part of the bidder’s supply chain. (ABC) created synergy because it streamlined its supply chain operations through conducting M&A transactions with (XYZ). The control premium is the value derived post deal from a change in management or management style. Will post COVID M&A activity generate more synergism or will it lead to new management approach? Something is destined to change.
With the wake of the pandemic, deal activity is being put on hold and firms are retracting any future plans they thought they had. Legal due diligence (the research conducted before the “handshake” which enables the bidder to confirm contracts, customers, and finances of the seller) is hard to conduct “remotely”. Therefore, we are seeing diminished deal activity. Furthermore, in an age of teleworking and “smart working” we are seeing a fundamental shift in the system. This adaptation could bring more digitization to legal M&A which could provide an interesting path to alter business models for a post pandemic reality. Legal deal activity could see synonymy between tangible and digital life creating a long term horizon to come.
4cLegal is at the forefront of this type of innovation using its “digital beauty contest platform” as a parallel. 4cLegal developed a platform to create a more efficient system between clients and lawyers. The digitization and usage of an online marketplace was conceptualized to increase productivity. The system is set up to pair institutional clients and lawyers together according to data inputs, finding the best possible match. What if the same concept can be applied for M&A activity? Is there a way to increase the efficiency of legal M&A transactions in a post pandemic world?
If you look at the current slowing of M&A activity, we know the “why”. The economy is closed. There is more uncertainty which has caused less volume in deal activity. Deal activity takes time and time has come to a halt. When we come out of the tunnel, we could see a pent up demand for deals because with fundamental change comes a new wave of thinking and strategy. In order to get the recovery underway, there will need to be an innovative approach to “normalize” deal activity. Behavioral finance says that herd mentality will cause a “revamp” in strategy across the board. Therefore, deal activity will have to increase because of how the world just changed forever.
Firms will be coming out of the other side of this pandemic “cash rich” and will be looking for new ways to innovate their products/services. The future of deal activity will change short and long term models/strategy and therefore, the way firms operate in the century to come.